ITAD Ruling No. 077-01

September 12, 2001 ITAD RULING NO. 077-01 RP-US, Art. 13 RP-Germany, Arts. 12 & 24 BIR Ruling No. ITAD-18-01 Castillo Laman Tan Pantaleon & San Jose Law Offices The Valero Tower, 122 Valero Street Salcedo Village, 1227 Makati City Attention: Atty. Zenaida O. Salipsip Anna Teresa C. Villacorta Gentlemen : This refers to your application for tax treaty relief dated March 16, 1999, on behalf of your client, Rhone-Poulene Rorer Philippines (RPRPI), to avail of the preferential rate of ten percent (10%) withholding tax on royalties to be paid by RPRPI to RPR Investments, Inc. (RPRII) pursuant to Article 13 of the RP-US Tax Treaty in relation to Article 12 of the RP-Germany Tax Treaty. It is represented that RPRII is a company organized and existing under the laws of the State of Delaware, that it is not registered as a corporation or partnership licensed to do business in the Philippines as per certification dated June 3, 1999 issued by the Securities and Exchange Commission; that it entered into a License Agreement with RPRPI, a company organized and existing under Philippine laws; that in consideration of royalties from RPRPI, RPRII grants the former the license to use its housemark; that RPRII has no branch or permanent establishment in the Philippines. Based on the foregoing representations, you are requesting relief from double taxation under Article 13 of the RP-US Tax Treaty which provides, viz : "Article 13 ROYALTIES "(1) Royalties derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States. "(2) However, the tax imposed by that other Contracting State shall not exceed (a) . . (b) In the case of the Philippines, the least of: (i) 25 percent of the gross amount of the royalties, (ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, and (iii) the lowest rate of the Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State . (emphasis supplied) "xxx xxx xxx" Considering that the lowest rate given to a third State is 10% as provided in Article 12 of the RP-Germany Tax Treaty which provides, viz : "Article 12 ROYALTIES "1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. "2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State, but the tax so charged shall not exceed: (a) . . . (b) 10 per cent of the gross amount of royalties arising from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, or from the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under (b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities. "xxx xxx xxx" it is your opinion that the 10% withholding tax on royalties provided in the RP-G ermany Ta x Treaty will apply to royalty payments to U.S. residents because this is the lowest tax ate embodied in duly ratified tax treaties which the Philippines has entered into. In reply, please be informed that the above-quoted Article 13(2)(b)(iii) of the R P-U S Tax Treaty, otherwise known as the "most favored nation clause", must be interpreted not only in relation to Article 12 of the RP-Ge rmany T ax Treaty but also in connection with Article 12 of the RP-Ge rmany T ax Treaty but also in connection with Article 24 of the same treaty, to wit: "Article 24 RELIEF FROM DOUBLE TAXATION "1. Tax shall be determined in the case of the resident of the Federal Republic of Germany as follows: "xxx xxx xxx" b) Subject to the provisions of German tax law regarding credit for foreign tax, there shall be allowed as a credit against German income and corporation tax payable in respect of the following items of income arising in the Republic of the Philippines, the tax paid under the laws of the Philippines in accordance with this Agreement on: "xxx xxx xxx" dd) royalties, as defined in paragraph 3 of Article 12; "xxx xxx xxx" c) For the purpose of the credit referred in subparagraph b) the Philippine tax shall be deemed to be "xxx xxx xxx" cc) in the case of royalties for which the tax is reduced to 10 to 15 percent according to paragraph 2 of Article 12, 20 percent of the gross amount of such royalties . (emphasis supplied) The Supreme Court has ruled in Commissioner of Internal Revenue vs. S.C. Johnson and Son Inc. and Court of Appeals (June 25, 1999) that unlike the RP-US Tax Treaty, the RP-Germany Tax Treaty allows a matching credit of twenty percent (20%) of the gross amount of such royalties arising the Philippines against German income and corporation tax, where the tax rate is reduced to a range of ten to fifteen percent under such treaty. Therefore, the taxes on royalties under RP-US Tax Treaty are not paid under circumstances similar to those in the RP-Germany Tax Treaty because of the absence of the said matching credit provision in the former convention. In so ruling, the Highest Tribunal further declares: "The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may be granted to the 'most favored' among other countries. The most favored nations clause is intended to establish the principle of equality of international treatment by providing that the citizens or subject of the contracting nations may enjoy the privileges accorded by either party to those of the most favored nation. The essence of the principle is to allow the taxpayer on one state to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation, in this case royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the R P-U S Tax Treaty and Article 12(2)(b) of the RP-We st Ger many Tax Treaty, above-quoted, speaks of tax on royalties for the use of trademark, patent and technology. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the design behind the most favored nation clause to grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment." The foregoing Supreme Court decisions has become final and executory on September 10, 1999. Moreover, the said decision and its doctrine shall be applied prospectively as provided in BIR Ruling No. 163-99 dated October 20, 1999. Such being the case, your opinion that the 10% preferential tax rate on royalties paid by RPRPI to RPRII is hereby confirmed, but only so much of the payments made from January 1, 1998 to September 10, 1999. With respect to royalty payments made after September 10, 1999 and onward, the 10% tax rate shall no longer be applicable for being contrary to the above-mentioned doctrine. In view of this, a new tax treaty relief application may be filed for transactions covering the remaining period covered by the License Agreement between RPRPI and RPRII, applying the "most favored nation clause" of the RP-US Tax Treaty citing other RP-Tax Treaties. Moreover, the said royalties shall be subject to the 10% value-added tax (VAT) based on the contract price, pursuant to Section 108 of the Tax Code. Accordingly, RPRPI shall, before making payment of royalties to RPRII, withhold and remit to this Bureau the said 10% VAT due thereon, by filing a separate VAT declaration/return using BIR Form 1600. The duly validated VAT declaration/return can be used as sufficient evidence for RPRPI in claiming input tax credit. (Sec. 4,102-1(b), Revenue Regulations No. 7-95) This ruling is being issued on the basis of the foregoing representations. However, if upon investigation it will be disclosed or discovered that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) EDMUNDO P. GUEVARRA Deputy Commissioner Legal & Inspection Group